THE GREAT DELEVERAGING OF 2009:

If companies want to avert bankruptcy, they have to purge their debts


The ‘D’ word has not only reared its ugly head, it is here to stay. Banks and businesses across the western hemisphere have to begin ridding themselves of a balance sheet financed by debt.

For those of us still grappling with this technical term – a dictionary description will tell you that deleveraging is: “The reduction of financial instruments or borrowed capital previously used to increase the potential return of an investment. It is the opposite of leverage.”

Now what this delightful explanation omits to mention is that companies which are highly leveraged – one’s which have borrowed a lot of money – are at a huge risk of bankruptcy if they are unable to make good on their debts.

Financial institutions are currently underway with the process of calling back loans especially from those who are seen as high risk borrowers. This is resulting in increasing the cost of credit for the rest of us and a drop in the value of investments.

Deleveraging isn’t only affecting banks and businesses – it is affecting homeowners as well. Real estate information supplier, Zillow said that 20% of American mortgage holders owe more on their home than the home is worth. At the same time more people are foreclosing on homes and when those homes go to be sold, there is a huge decline in price. There is little doubt that the real estate market has to follow in the deleveraging process to be able to sustain itself in the future.

The end result is that the spending patterns for both the consumer and business will languish and home valuations will continue to be under pressure back to 2003 levels relative to gross incomes. Paying down debt will take precedence over spending and business "Top line" earnings will be challenged. The reversal of this trend will take a few years to overcome.

An important footnote to all of this is the effect on the emerging economies. The International Monetary Fund (IMF) has said because emerging economies are reliant on external funding (from developed nations); they will need to adjust monetary policy to prevent capital outflows. They concluded that theses emerging markets are vulnerable to the deleveraging realized in advanced economies – like ours.

This crisis is indeed global.